US equity markets were unable to muster much conviction yesterday though volume did expand on the NYSE (+6.29%) and Nasdaq (+15.53%). All three major market indices fell with leadership lower provided by the Nasdaq (-1.10%). The Dow Industrials slipped 0.45% and the S&P 500 ticked 0.64% lower. The sector heat map reflected the lack of investor engagement with seven of nine sectors lower on the session while only the financials (+0.08%) and health care (+0.85%) managed to stay above water.
Many on the street were deeply disturbed and saddened by the ongoing and horrific challenges faced by civilized society at the hands of Islamic terrorists in the form of ISIS. There was a palpable shift in investor sentiment yesterday as we were all reminded once again of the challenges we face as a society in rooting out an enemy that has left all of us feeling more vulnerable. Additionally, tomorrow is Good Friday which for many on the street translates into a rare three day weekend.
US equity markets remain in a confirmed uptrend. The S&P 500 and Dow Industrials are both well above their 50 and 200 DMAs. Earnings season, interest rates and economic data will provide the narrative which will likely lead to further gains in the near term though we may well be a bit stretched at the moment.
How I See It…
As I have suggested in several contributions to financial media outlets this week, the largest headwinds for the current run up in equity prices is Q1 earnings. We will be provided some backstory on the upcoming Q1 corporate results with this Friday’s Economic Calendar which will include revised Q4 GDP data and Q4 corporate profit and revenue metrics. Though backward looking and not expected to generate much in the way of excitement, this Friday’s economic data release is very important. Real GDP – Q/Q change – SAAR is expected to remain 1%. The GDP Price Index – Q/Q change – SAAR is expected to come in at 0.9%.
As I have discussed, many on the street have interpreted the YOY slowdown in Q3 (-5.1%) and Q4 (-9.5%) pre-tax earnings of last year as an indication that we may well see the US economy stall and ultimately succumb to negative growth in this year. The additional hurdle in place with the shift in monetary policy by the Fed provides further justification for concern on the part of many. After all, the combination of Q3 and Q4’s result were the worst since the financial crisis.
Margin compression as a result of rising unit labor costs, stagnant productivity growth and little to no pricing power have all left companies with few choices when it comes to defending earnings. The most obvious of choices has been to reduce headcount. Given the historically low rates of unemployment, headcount reductions appear to have been well digested by the economy thus far. In as far as pricing power is concerned, as employment growth continues at a robust pace and if the meager signs of inflation that we have seen gain some momentum, corporations will likely be able manage a degree of margin expansion that has heretofore escaped them. Productivity is another challenge though. It is a challenge most effectively addressed in an economy that is expanding at a more robust rate than the revised 1% annualized that was posted for Q4.
Inflation is the key. The great divide that has emerged at the Federal Reserve in recent weeks has everything to do with inflation.
With the economy now at near full employment and with inflation close to 2% target, the odds of a rate rise in June is increasingly more likely. Some have even called for a move in April. As I have stated in recent notes, June is the more likely month as it will provide the Fed and the economy more time for employment gains and an uptick in inflation.